Islam is a divine religion sent down by Allah to mankind through His prophet Muhammad (PBUH). It has come with so many goodness as well as initiated so many ideals that were later developed into magnificent projects today. Among such is the Islamic Banking system.
Islamic banking refers to a system of banking, which is consistent with Islamic Shari’ah, and guided by Islamic economics. Islamic law prohibits the payment and collection of interest or usury. Features of Islamic Banking are based on ethical principles.
Main conditions governing Islamic investment include: Money does not generate or beget money in itself, but it becomes productive if it is involving an activity or work; Investment is subject to the rule of profit and loss sharing; Investment in business activities is lawful, but prohibitions should be avoided. Contracts must be free of uncertainty, ignorance and the conditions which lead to disputes.
The Islamic Economic System revolves upon the prohibition of Riba (interest). The two main types of usury to be avoided are as follows:
1- Riba al Nasi'ah:
This is defined as: “any excess compensation over and above the principal which is without due consideration.”
The Prophet (PBUH) said: “Every loan that draws interest is Riba”.
Riba al-Nasiah, or deferred usury, is related to extension of the repayment period for additional payment of money. It is also called Riba Jahiliyyah which was a pre-Islam form of usury and the worst of its kinds.
2- Riba al-Fadl:
Riba al-Fadl means the excess which is taken in exchange of specific homogenous commodities, such as selling gold with another gold, whereby one has more “weight” than the other.
The Prophet banned all interest based transactions and abolished all interest due to and accruing from the people of Taif's condition of the Taif Treaty.
PRINCIPLES OF ISLAMIC BANKING
Islamic Banking is based on the principles of trade, partnership, sharing of gains and losses, and prohibition of reckless risk. It prohibits:
Gharar –unclear contracts
Financing of haram transactions -– alcohol, gambling, pork, etc.
Lending in Islamic Banking
Islamic Financing involves a buy-sale deal or a rent to sale deal. There is always an underlying asset behind the deal. Allah reminds us: “We have permitted trade and forbidden riba”. In Islamic banking, the lender must share the risk with the borrower. It deals permisbly on sale contracts (murabahah), part financing (mudarabah), leasing (Ijar), overdrafts (tawarruq), partnership (musharakah) etc.
Deposits in Islamic Banking
Clients deposits fall under the category of qard (Loan) to the bank and the bank is obliged to pay back. These loans fall under the category of Musharaka. The bank is obliged to share in the profits of the bank with its depositors. Bank must protect these assets on behalf of its clients as well as get them the highest halal returns. Since banks do not pay interest, clients must therefore become partners or Mushariks to share in the profits. The only way to become a partner is to open an investment account (Time or Saving Deposit) which allows the bank to invest one’s money. Profit sharing is then calculated and distributed. Profits will be very close to prevailing deposit rates.
Types of Accounts in an Islamic Financial Institution (IFI)
In Islamic banking each customer is a partner with the Islamic Financial Institution (IFI). This relationship is classified as a Mudarib Partnership. Profits resulting from the account are divided between the parties. An IFI receives a certain percentage of the net profits, as a return for the amounts deposited in different investment accounts as its share, being a Mudarib, as agreed between the customer, who is the investment account holder, and the IFI.
This is a brief on the way the Islamic banking operates. Its recent impact on the global economics and banking cannot be over emphasized. It was the only banking system that scaled through the recent economic meltdown without a bruise. The equilibrium it builds and maintains between the rich and poor in the society is another point of interest. The high rate of risk control in its balanced most considerate leasing and borrowing/payment policies compared to its secular counterpart is overwhelming. It is the first and only banking system that practices banking with ethics.
In a nut shell, being a divinely revealed and prepared system is enough to make it a wonderfully amazing banking system. Thus, its impact and contribution to the banking system is tremendously gaining awareness and hugely being implemented, even in the so called secular states.